TAX PROGRESSIVITY AND SHARE OWNERSHIP

November 30, 2005

Personal taxes have shaped the concentration of stock ownership in the United States during the twentieth century, say authors Mihir Desai, Dhammika Dharmapala and Winnie Fung.

The authors found that increases in the progressivity of a tax system lead to a greater personal tax burden on corporate debt, relative to equity. This induces more equity issuance and, consequently, a larger fraction of investors to hold equity. In short, the marginal investor becomes a lower income individual.

In contrast to the typical portrait of the United States as having diffuse ownership patterns throughout the 20th century, the authors found that there was significant variation over time, with substantial diffusion of ownership after WWI and again through the 1950s. While diffusion persisted through the second half of the century, an increase in concentration of aggregate corporate ownership returned in the 1990s. Furthermore:

The analysis reveals increases in the progressivity of individual income tax rates are associated with statistically significant and economically meaningful increases in the diffusion of corporate ownership.

These results hold after the authors control for a variety of factors, including changes in economic conditions, income distribution, stock valuation, the fraction of households filing tax returns, and corporate and capital gains tax rates.

Controlling for these various factors, a change in the top statutory rate is associated with a corresponding change in the index of ownership concentration.

Separate analysis by income classes confirms these results and provides only weak evidence for the role of stock valuation levels for equity market participation.

These results support the notion that taxation can affect shareholding patterns and, consequently, concentration of ownership and stock market participation. In particular, the findings suggest that the progressivity of the tax code may be a contributing factor in stock market participation at lower income levels.